How to Pick the Best Darned Account for You

What, you're not familiar with this holiday? Well, it might because we at The Motley Fool invented it, and today is the first time we're going to celebrate it — all day long, over on Fool.com.

For today's post, I'm borrowing one of the videos I shot for Invest Better Day. The Fool has long had the 13 Steps to Investing Foolishly, and we recently put them to video. One of my installments was about choosing the right investment account for your goals, filmed with the assistant of my colleague Lyons George. Here 'tis:

Now that you've seen the video and brushed your teeth, here are the answers to some commonly asked questions about retirement accounts.

Q: What are those restrictions about IRAs you mentioned in that video?

Here's what you need to know: Whether contributions to a traditional IRA are deductible starts with whether you (or your spouse, if you have one) are covered by a retirement plan at work. It doesn't matter whether you participate in the plan, just whether your boss provides the opportunity.

Then, it comes down to your household adjusted gross income (AGI). Here are the important numbers if you are NOT covered by a retirement plan at work. Here are the numbers if you are covered by a retirement plan at work.

Contributions to a Roth IRA are never deductible, but your income will determine how much you can contribute, including whether you can contribute to a Roth at all. Here are the income limits for 2012.

Q: Can I contribute to both a 401(k) and an IRA?

A: Yes. The only way that one affects the other is in the determination of whether contributions to a traditional IRA are deductible.

Q: What if I need the money before I turn 59 ½ year old?

A: Withdrawals before age 59 ½ might be subject to income taxes and a 10% penalty. But there are plenty of exceptions, including:

Contributions to a Roth IRA (not earnings) can be withdrawn any time, tax- and penalty-free. The earnings might be taxed and penalized. Early withdrawals from a Roth 401(k), on the other hand, are always a mix of contributions and earnings (if you have any).

You might be able to make penalty-free withdrawals from your last employer's plan if you retire at age 55 or older.

Under rule 72(t), you can make substantially equal periodic payments (SEPPs) at any age by agreeing to take out a certain amount each year until you turn 59 1/2 or for five years, whichever is longer.

IRA assets used to pay for qualified higher education expenses — such as tuition, fees, books, and room and board — are exempt from the 10% penalty.

You can use your IRA to help put a roof over your head, as long as you're considered a first-time buyer, which, according to the IRS, includes anyone who hasn't owned a home in the past two years. There is a $10,000 lifetime limit on what can be withdrawn penalty-free.

However, keep in mind that you're playing with fire when you tap retirement accounts early, both in terms of the near-term consequences (taxes and penalties) and long-term consequences (not having enough to retire). Consult a tax pro beforehand to make 100% sure that you're doing things right, and that you're aware of all the consequences as well as most recent rules.

Q: Is the Roth named after J.D. Roth, germinator of this website?

A: No, it's named after Delaware Sen. William Roth Jr., also known for leading investigations into Pentagon overspending that uncovered expenditures on $640 toilet seats and $9,600 wrenches. As for J.D., he is the namesake of the Roth “I'm so cool I no longer need a beard” look.

Q. How do I know if my 401(k) stinks?

A. It comes down to knowing who's paying the fees (you or your employer), what those fees are, and the quality of your investment choices. This should be somewhat easier, now that providers have to reveal more detailed fee information in quarterly statements. But if you want to dig deeper, we recently wrote about how to evaluate your plan and what to do about it.

Q. Does “IRA” really stand for “Individual Retirement Arrangement”?

A: That's what the IRS says, as demonstrated by the headline of Publication 590, which has everything you need to know about IRAs… and way, way more.

Q. But there are no cat pictures in Publication 590. Where can I go to read even more about the exciting world of retirement accounts, but with cat pictures?

Ellen Cannon was the editorial director of the financial services sites at QuinStreet from 2010-2015. She has covered personal finance for magazines and websites for more than 20 years, including five years as managing editor of Bankrate.com. She lives in South Florida with her kitty and sunshine.

A key point to remember when evaluating a 401(k) compared to an IRA is employer match. If your employer matches a percentage of your contributions you’d be giving up free money by not participating.

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Tom

7 years ago

Love the videos. Great Job Robert!

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Holly

7 years ago

I am so glad I read this, because I didn’t realize my husband qualified to contribute to a regular IRA as well as a Roth. (His current employer does not cover his retirement.)

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mark

7 years ago

You touched on a subject that was the source of much frustration at the beginning of this year. My wife’s employer offers a 401k plan but is not currently matching any contributions. As a result, we see no reason for us to participate in that plan (and haven’t) since the investment choices are poor. We have been fully funding two Roth IRAs (hers and mine) for the past few years. However, this year I thought about changing her investments to a traditional IRA instead of Roth to hedge our tax bets. That is when I was looking into eligibility requirements… Read more »

Ok, so the article says that the employer simply has to have a 401k available, but the IRS tax forms seem to indicate that you actually need to participate…

I’m looking forward to having this clarified.

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Bored

7 years ago

Unfortunately GRS remains stuck in “basic” mode with information available to anyone who has read any of the many Intro to Financial Planning books. How about talking about the interaction of asset allocation in Roths vs. traditional tax-deferred accounts? How a traditional pension affects this decision (i.e. the fact that lower tax brackets will be filled with pension in retirement)? I little bit of “intermediate” posts would be welcome on the site.

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S

7 years ago

is that a rugby ball in the background 🙂

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rosarugosa

7 years ago

I loved the videos and felt bad that I wasn’t able to access the comments yesterday. Did others have the same experience? I suspect that’s why there are so few comments. DH actually watched a personal finance video with me because he didn’t want to miss out on the source of my mirth 🙂

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Hi! I’m J.D. Roth. I'm here to help you master your money — and your life.

General Disclaimer: Get Rich Slowly is an independent website managed by J.D. Roth, who is not a trained financial expert. His knowledge comes from the school of hard knocks. He does his best to provide accurate, useful info, but makes no guarantee that all readers will achieve the same level of success. If you have questions, consult a trained professional.

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